Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Thursday, September 16, 2010

Uncertainty over New Deals

We live in uncertain times...that's for sure!

Lot's of chatter these days about what role the uncertainty over future policy regimes is playing in holding back a complete economic recovery. On the one side, we have the usual suspects claiming that the problem has little, if anything, to do with policy uncertainty. Instead, it is a lack of "aggregate demand." Mark Thoma provides a link to an interesting study here that appears to support this hypothesis--on the surface, at least.

The study highlights the fact that small businesses are citing a lack of sales volume as their main source of trouble. Well, sure. But it's not immediately obvious what this micro data tells us about the empirical relevance of the theory of "effective demand failure" in the current climate. Small businesses living in an intersectoral real business cycle model (a la Long and Plosser, JPE 1983) are likely to report similar things in the event of a large negative shock to an important sector of the economy (like the residential investment sector). If I'm a supplier of home furnishings, I'm going to cite a lack of demand for my product. But does this necessarily mean that the macro problem is a lack of aggregate demand? Possibly--but not necessarily.

In an earlier post, I entertained the idea of investment demand falling off the cliff in response to fundamentally bad news relating to the future return to capital spending; see here. I still think there is some merit in this idea, though the data I presented here has led me to re-think this position. I could be wrong, but I think this data presents a similar difficulty for standard Keynesian interpretations of investment spending collapse. In particular, the survey data I cite shows that long-horizon forecasts of real GDP growth remain resiliently optimistic throughout the worst parts of the recession. (Presumably, it is the long-horizon that bears most forcefully on current planned investment decisions). The same data shows an increasing amount of "uncertainty" (or disagreement) over forecasts. Of course, the data does not tell us the source of this uncertainty; but it seems reasonable to suppose that at least some of it is being generated by the government and the Fed (Disclaimer: the views expressed here are obviously my own!)

Drawing lessons from the New Deal for the Great Depression requires, first, and understanding what the New Deal was. It was a gumbo: FDR took everything that was on the kitchen shelf and threw it into the pot on March 4, 1933 and then began stirring.

He quotes FDR himself as saying:

The country needs and, unless I mistake its temper, the country demands bold, persistent experimentation. It is common sense to take a method and try it. If it fails, admit it frankly and try another. But above all, try something.

Now, whether you agree with FDR's approach here or not, I think you'd be hard pressed to argue that it did not contribute to a heightened degree of uncertainty over the likely future path of policy interventions. But clearly, something had to be done; so perhaps this approach was defensible under the circumstances.

Or was it? What sort of "common sense" was FDR referring to anyway? The U.S. economy had experienced severe economic contractions prior to 1930, the most recent in the early 1920s. While severe and distressing for many people, the economy always recovered on its own (the size of the federal government in those years was tiny in comparison to today). What was it about the contraction in 1930-33 that made it so much more different than before? Was there any reason to believe at that time that the economy would not recover on its own as it did before, without anything resembling a New Deal intervention? Why did the contraction of that period result in a "lost decade?" Is it really crazy to suppose that FDR's "gumbo soup" approach may have prolonged the misery of that decade? I honestly do not know the answer to these questions, but I think they should be taken seriously.

Many people appear to buy into the standard myth of an established and stubborn free-market orthodoxy, led by Herbert Hoover, ready to drive the U.S. economy to hell--until FDR saved the free world with his New Deal. My own reading of that period in American history has left me with a different perspective (my views are still evolving as I continue to read, of course).

The economic orthodoxy of the time was largely persuaded by the benefits of countercyclical public works (see, Fabricating the Keynesian Revolution, by David Laidler). And Herbert Hoover was (initially, at least) a big proponent of public works (remember, he served as Secretary of Commerce from 1920-28). He described himself as a "progressive" and a "reformer" and in his writings, he criticized laissez-faire economics. His response during the great contraction was to introduce his own New Deal; see here.

Naturally, Herbert Hoover's New Deal had many critics. Not the least of these were the Democrats in Congress (who were in a majority at that time), led by FDR himself. I am still reading through the history of that time (one needs to check several sources, since there appear to be conflicting reports and interpretations). But it seems clear enough that there was quite a bit of political wrangling going on--very much like what we see today, in fact. The Democrats at that time (much like the Republicans today) apparently did everything they could to stonewall the President and his policies. But at the end of the day, many of FDR's New Deal policies were lifted from Hoover's. Consider, in particular, this quote from one of FDR's early advisers (Raymond Moley, writing in Newsweek, June 14, 1948):

When we all burst into Washington...we found every essential idea (of the New Deal) enacted in the 100-day Congress in the Hoover administration itself. The essentials of the NRA, the PWA, the emergency relief setup were all there. Even the AAA was known to the Department of Agriculture. Only the TVA and the Securities Act was drawn from other sources. The RFC, probably the greatest recovery agency, was of course a Hoover measure, passed long before the inauguration.

Of course, the U.S. economy continued to collapse despite Hoover's New Deal. Does this not require some explaining? The most tumultuous events appear to coincide with the period between Hoover's election loss and FDR's official appointment to office. Consider this quote from here:

The election brought hope to many Americans in the autumn of 1932.But Roosevelt did not become president until March 1933, four months after the election. And those months saw the American economy fall to its lowest level in the history of the nation. President Hoover tried to arrange a world economic conference. And he called on President-elect Roosevelt to join him in making conservative statements in support of business.Roosevelt refused. He did not think it was correct to begin acting like a president until he actually became the head of government. He did not want to tie himself to policies that the voters had just rejected. Congress, controlled by Democrats, also refused to help Hoover.It was a strange period, a season of uncertainty and anger. The Economic Depression was worse than ever. The lines of people waiting for food were longer than before. Angry mobs of farmers were gathering in the countryside. And the politicians in Washington seemed unable to work together to end the crisis.Hoover said: "We are at the end of our rope. There is nothing more we can do." And across the country, Americans waited -- worried, uncertain, afraid. What would the new president do?

Whatever one's political philosophy, I think that we might all agree that uncertainty over policy regimes has played a role in past depressions. And it may very well be playing a role in depressing the current recovery.

33 comments:

Good post. Robert Higgs, by his own reckoning, is a pariah since he has left his neoclassical roots behind. But the Independent institute published interesting heterodox work in political economy and is nice Sunday night reading.

You may find Murray Rothbard's "America's Great Depression" a good read. He devotes a good deal of space to Hoover and Roosevelt.

Kennedy, from Stanford, talks about the New Deal here: http://www.econtalk.org/archives/2010/08/kennedy_on_the.html. It's also quite good, but again it's sort of Sunday night listening.

The trick, given accepted methods in economics and finance, is that uncertainty of this sort is extremely difficult (I won't say impossible) to estimate and incorporate into our models.

Scott Sumner has argued that FDR's raising the price of gold (loosening monetary policy) was the one really good thing he did. But that raising nominal wages and prices undid much of the good of that policy, because it's like reducing the money supply in real terms.

Did that happen before or after FDR confiscated everyone's gold? I get that the importance here is the use of gold as a means of exchange, and that was still allowed, but still. And, I think gold confiscation helps the uncertainty argument.

Nice post David. As usual thought provoking and well cited. I do however think the "uncertainty" argument, which is becoming quite prevalent in the non interventionist circles suffers from an inability to define what "certainty" looks like. It is usually talked about as if the only uncertainties that businesses suffer from are govt regulations and taxes. Its like, "If we could only eliminate those, we could get back to accurately predicting our capital needs and know exactly how many employees we could take on" (which is supposedly a lot more than we are taking on now) Is it really true that only the ogre of government provides those business killing uncertainties? I'm not claiming this is YOUR claim, but it seems to be the claim of many.

The trouble I think with this line of argument is that it suffers from oversimplicity, ambiguity and a disturbing level of UN-falsifiability. How can anyone ever prove that a person claiming uncertainty is in fact being truthful or deceitful. Maybe some day we can put a business leader in an MRI and look to see if his "Uncertainty area" is in fact "lit up" when he says it is but until then..............................

Your post definitely demonstrates that the GD was an unusual time both in the real economic affects AND how politicians responded. Prior to this time there was no MACRO economic thinking at all. The whole field of macro was developed in the GD era. That event inspired new paradigms.New measurements were done and a whole new way of treating the worker as a part of the economy evolved. Comparing economic growth from the 1920s when new industries and ideas were coming on board almost monthly is not a fair comparison. As much as the recovery from the 20s depression is to be lauded (by the metrics) would you really want to argue that the 1920 auto workers were "better off" than those in the 1990s? There were so many ways for the 1920s economy to grow, so many places that were ripe for exploring. I'm not sure you could argue that the govt of the early 1900s had nothing to do (or even little to do) with the huge growth of the pre GD era. No it didnt respond to the early twenties downturn with stimulus packages but can you really credibly argue that if it had that things would have been worse? The financial crisis of 1929 was not the same as the recession of the 1920s. Not in any way shape or form. Equating the two is like equating how someone recovers from a cold vs recovers form the swine flu.

All that being said means Im going with the "loss of aggregate demand" argument. 1) We can actually do something about that (and to date the monetary responses have NOT addressed AD contrary to the "treasury view") 2) It aligns with how businesses actually act. They ALWAYS sell more when more people come through the door asking for their product. And often this leads to the business hiring people BEFORE they simply raise a price. 3) Its measurable unlike "certainty".

Now this doesnt mean that I view our low AD as a sign there is not enough money IN the economy. There is plenty its simply distributed in a way that is lowering activity. So we have two options as I see it 1) coax the money out of the places where it is to places we would like to see it.This has been tried for 2 plus years to very little success. Telling a business they can keep more of what they earn means little when no customers are knocking on their doors. Dong this via credit markets is questionable given the state of most peoples credit situation already.Or 2) Put money into the peoples hands you would like to have it. Do this by direct salary subsidization ( through a JG program) and payrol tax holidays. This gives the unemployed a salary and the employed more income.

Your post raises a number of fallacies, and I'm not patient, so I hope David doesn't mind that I respond to a couple of them.

First, your statement that macro thinking only arose during the Great Depression in patently false. From the economists point of view, Ricardo and Smith and Mills were political economists and their work certainly dealt with macro issues. Politically speaking, Smith and Ricardo were working at a time when many statesmen were by and large mercantilists - another macro story.

If you mean the development of Keynesian macro and the NKs which followed, then this is true, but it is merely a tautology. It's like saying the Great Depression made us think about the Great Depression. It is a false division anyway, since macro results are made up strictly of micro agents' decisions.

Second, what do you mean by aggregate demand? You seem to suggest it is sales by business to consumers, and thus we would call it consumption. Well, the problem with that story is that it is falsifiable. Consumer spending is the least sensitive portion of the GDP identity to business cycle fluctuations. Investment is the sensitive one.

Anyway, right now consumer spending is around 10 trillion dollars based on annualized quarterly data. A touch lower in 2009 than 2008, but about the same, and those years were both higher than 2006 and 2007.

Finally, if you want to say that a source of business uncertainty is future sales then that is most certainly true. But it leads to a follow-on set of questions: are businesses more uncertain regarding future sales now than they are typically? If so, why?

My statement about macro and the great depression may be incomplete but its not patently false. Keynes addressed things in a completely new way. He recognized the two sided coin of labor both a cost to business yet also on the other hand the very income which people use to actually be customers. The standard thinking at the time (and still mystifyingly prevalent today) was labor as a commodity along the lines of an apple that employers choose to buy. If the price of labor is too high people wont buy it and we will have unemployment. The utter density of that view was exposed by Keynes but those that held (and hold) to it refuse to acknowledge their shortcomings and continue to spout it. Against ALL evidence. Of course to see this one must look past their microeconomic nose and understand the fallacy of composition. One firm cutting wages may be of benefit to that firm, all firms doing so will ONLY be deflationary and self defeating to all firms. Their sales will fall and they will lose all their savings of labor costs.

Ricardos prime contribution to macro (Ricardian equivalence) was essentially the completely obvious statement that all actions have consequences.... thank you Mr Ricardo we never would have figured that one out without you.

This......"macro results are made up strictly of micro agents' decisions."..... while true, illuminates nothing. The fallacy of composition already provides the ammunition for showing that something which an individual might do to pursue self interest will end up hurting him or at least taking away every advantage gained if everyone else does the same thing. This of course is why mercantilism cant succeed for all countries, there must be a net importer to support a net exporter. If you tried to make the statement "All we have to do to understand what is best for the economy as a whole is ask any representative agent what is best for him and we would find our answer" you know that would be false. Your statement treads close to this fallacy. Knowing what something is made of is only half the battle. How that collection of micro decisions look in aggregate is the real question we are trying to answer.

AD is certainly measured in sales, which also encompasses GDP. The number of monetary transactions IS the level of measured economic activity. Now I'll be the first to suggest our preoccupaion with GDP has led to an unhealthy focus for our economy but that is what we have. AS WE CURRENTLY MEASURE IT, economic activity is dependent on people with money (businesses are people in this story too) going to other people and "demanding" something. When that stops businesses have less sales, revenues fall and they lay off workers. This isnt a just so story. It accurately depicts what businesses do every day of the week. So the lack of people with money going and asking for stuff DIRECTLY leads to unemployment. Those people going to seek things in aggregate are the AD.

If you found out that the 10 trillion in spending was 10000 billion dollar transactions would that affect how you viewed that number. Spending on a stock purchase or a secondary market bond purchase or a gold purchase will not have the same affects on employment as say orders for 10 million cars but they may have the same nominal amount. I dont think there is much meaning to your number without some context.

I really like your last question. I'll speculate and say that the most important factor in determining what they think is going to happen in the future in regards to sales is what are present sales. If they have been experiencing fewer customers that affect their expectations more than anything. So bring them more customers through the door and they'll start being more certain about FUTURE sales.

While my statement about macro thinking during the GD may be incomplete its not patently false. Prior to that time there were not the measurements of the different metrics and focus on employment to the degree there was after the 1930s.

Keynes most certainly took on some issues that had never really been questioned by classical economists and brought them to the forefront.The idea that labor was a commodity like an apple and its price (wage)determined the degree to which it was purchased was attacked by Keynes. He pointed out that unlike apples, labor wage was not only a cost to business it was also the salary which enabled a worker to buy your fellow businessmans product. Efforts to suppress wages thinking they would increase your profits will only result in unemployment and lost revenues to businesses.... a race to the bottom. The fallacy of composition is what was operative here but yet it was (and often still is) ignored by those ideologically bound to using labor as an inflation suppression tool.

Ricardo and his equivalence can be summed up, I think, as a paraphrase of "every action has consequences". Not exactly earth shaking. I think we figured that out for ourselves, thank you Mr Ricardo.

What does this...... "macro results are made up strictly of micro agents' decisions"........ mean? Yes and a body is made of cells and a rain cloud is made up of water droplets. Does the rain cloud simply behave as a large water droplet? Is there not utility in understanding that the sum of parts behaves quite differently form the individual parts and in fact CANNOT be understood (and predicted) by merely understanding the components. You cant understand mass unemployment by simply understanding why Joe got fired form his job at the factory.

Aggregate demand? While its not simply consumption it is contained within it. Let me state first off that I dont hold to GDP as the Holy Grail of economic health, nor do I hold the Dow as such either (I'll take GDP over the Dow btw but thats another discussion). However GDP is the metric of the day along with unemployment and Dow levels. Economic activity is what all these things reflect. If no one is trading stocks the Dow is poor, if no one is spending any money GDP is poor and unemployment is low. A person using money to request a service is economic activity, a barter is as well but it does not contribute very much. When businesses see fewer customers they lay people off if it goes on for long. Customers are demand. Unemployed are very poor customers. It cant get much simpler.

Your consumer spending data is incomplete. What if that is simply 10,000 billion-dollar transactions? What if it is mostly purchases of secondary market stocks and bonds or purchases of gold and silver? Will this be as employment generating as the sale of 10 billion cars?Theoretically that 10 trillion could have been one consumer to purchase one thing. There is a lot of information lacking in your number.

Your last question is a good one, and I would answer it such. In aggregate the future expectations are likely driven by present and most recent conditions. Fewer customers have been coming through the doors for most people, they rationally expect the same tomorrow. I dont think they are any more uncertain, when customers were coming through the door they expected it to continue, rationally. Their certainty level was the same their pessimism/optimism was different. Businesses looking for certainty are foolish, looking for customers is what they should be doing. When customers start coming through the doors they'll respond positively.

Greg, Sorry, this is long. I tried to respond to each paragraph in turn.

I agree that modern empirical concepts of macro-relevant statistics date from this period. I don’t know if this is good or not, from a normative perspective. On the other hand, some data is better than no data. I disagree with the characterization of focus on employment, however. Mercantilists were well known to desire the full employment at all times of the people in a country. If you mean the measurement, as we know it today, of employment and the concepts of frictional/structural/cyclical, then sure; these are Keynesian ideas.

The value of the labor and the wage paid are two different things. A business cannot overpay for its labor without taking monetary resources from another part of the business. This could result in underemployment of labor, or lower returns to shareholders, for example. And, if labor costs are in general higher, then the costs may be passed on to the customers. So, yes, the wages are income for the worker, but a wage paid beyond the worker’s added value is deleterious to the business, and potentially to customers. This is not different from apples, since one must also pay for apples and too high of a price for apples will cause a business to seek an alternative input.

There’s more to Ricardo than the equivalence theorem. Also, it was advance at the time when mercantilism was dominant so Ricardo’s work was significant forward progress.

I mean that macro “agents” (like countries and governments) are not decision makers. So, yes, you can understand why mass unemployment exists by understanding the myriad reasons why people (not just one person, mind) were “fired.” Macro aggregates cover up all kinds of really interesting behavior that doesn’t show up when you add everything together.

At least we agree that GDP isn’t the ne plus ultra of measuring economic health, so there’s a start. I quibble with your choice of the DJIA as a measure of stock market health, but I get your point. But, so if AD isn’t just consumption, then the other major parts are investment and government expenditure. And investment is exactly what we’re talking about here. Why aren’t businesses investing? This is where the economic cycle begins, after all.

Well, given it is the number from the BEA, the composition is mostly small transactions, and lots of them. But, I don’t understand why you think it makes a difference.

My point is that the customers are spending the same amount of money as they were before. Or did that slide by? That’s what the BEA consumption number measures. The issue appears to be business-to-business sales, not household consumption.

“Is there anyone who can just create a "customer" out of thin air?”Yeah – the government.

Greg, sorry, this is long. I tried to respond to each of your paragraphs in turn.

I agree that modern empirical concepts of macro-relevant statistics date from this period. I disagree with the characterization of focus on employment, however. Mercantilists were well known to desire the full employment at all times of the people in a country. If you mean the measurement, as we know it today, of employment and the concepts of frictional/structural/cyclical, then sure; these are Keynesian ideas.The value of the labor and the wage paid are two different things. A business cannot overpay for its labor without taking monetary resources from another part of the business. This could result in underemployment of labor, or lower returns to shareholders, for example. And, if labor costs are in general higher, then the costs may be passed on to the customers. So, yes, the wages are income for the worker, but a wage paid beyond the worker’s added value is deleterious to the business, and potentially to customers. This is not different from apples, since one must also pay for apples and too high of a price for apples will cause a business to seek an alternative input. It means that macro “agents” (like countries and governments) are not decision makers. So, yes, you can understand why mass unemployment exists by understanding the myriad reasons why people (not just one person, mind) were “fired.” Macro aggregates cover up all kinds of really interesting behavior that doesn’t show up when you add everything together.I’m not sure where to start here. At least we agree that GDP isn’t the ne plus ultra of measuring economic health, so there’s a start. I quibble with your choice of the DJIA as a measure of stock market health, but I get your point. But, so if AD isn’t just consumption, then the other major parts are investment and government expenditure. And investment is exactly what we’re talking about here. Why aren’t businesses investing? This is where the economic cycle begins, after all.

Well, given it is the number from the BEA, the composition is mostly small transactions, and lots of them. But, I don’t understand why you think it makes a difference.

My point is that the customers are spending the same amount of money as they were before. Or did that slide by? That’s what the BEA consumption number measures. The issue appears to be business-to-business sales, not household consumption.

“Is there anyone who can just create a "customer" out of thin air?”Yeah – the government.

Greg, I'm not able to post a huge response to you here (I've tried) so I'll do my best in the quick&dirty method available.

To para #2: The value of the labor and the wage paid are two different things. A business cannot overpay for its labor without taking monetary resources from another part of the business. This could result in underemployment of labor, or lower returns to shareholders, for example. And, if labor costs are in general higher, then the costs may be passed on to the customers. So, yes, the wages are income for the worker, but a wage paid beyond the worker’s added value is deleterious to the business, and potentially to customers. This is not different from apples, since one must also pay for apples and too high of a price for apples will cause a business to seek an alternative input.

To para #5: I’m not sure where to start here. At least we agree that GDP isn’t the ne plus ultra of measuring economic health, so there’s a start. I quibble with your choice of the DJIA as a measure of stock market health, but I get your point. But, so if AD isn’t just consumption, then the other major parts are investment and government expenditure. And investment is exactly what we’re talking about here. Why aren’t businesses investing? This is where the economic cycle begins, after all.

Finally: Well, given it is the number from the BEA, the composition is mostly small transactions, and lots of them. But, I don’t understand why you think it makes a difference.

My point is that the customers are spending the same amount of money as they were before. Or did that slide by? That’s what the BEA consumption number measures. The issue appears to be business-to-business sales, not household consumption.

“Is there anyone who can just create a "customer" out of thin air?”Yeah – the government.

I'd say the abrogation of the gold clause may have caused the most uncertainty in the 1930s. The confiscation of gold only occurred in the US, but the removal of the gold clause was pretty much an international phenomenon.

A large chunk of society's long term contracts were suddenly stripped of their already-negotiated indexation to some physical quantity of gold. In gold's place as these contracts' unit of account was substituted some fiat unit. I doubt that helped people's desire to commit to subsequent contracts.

I believe the "guy"--Robert Higgs--has a valid point too. Unfortunately his argument and similar kinds of arguments stretch the data far beyond testing.

Higgs published a fascinating article most cleverly entitled "Legally induced technical regress in the Washington Salmon Fishery" in 1982. That article is available on the Independent Institute's web-site here: http://www.independent.org/publications/article.asp?id=2453

You switched from my "cost" of labor and tried to insert "value". Do you believe they are interchangeable? My argument was that cutting labor costs, which is only reflected in wages, was self defeating if attempted in aggregate. You're back to arguing that unemployment is simply a symptom of too high of wages. I wonder why no one was screaming in 2007 that we were all overpaid and that if we didnt take paycuts we'd suffer mass unemployment. I still dont see how you can say a worker is just like an apple (in the market) does the apple take the price you pay for it and use it to purchase grapes or something? There are not two sides to the apple coin.

In reality investment is just another form of spending or consumption. I invest in a new factory, I buy labor, equipment, a building...... these end up as wages and savings for someone else. Same with govt spending. I would say that the economic cycle begins when someone comes and demands something for you to invest in. Otherwise your subscribing to "Field of Dreams" economics..... If you build it they will come. Theres a reason that was a dream in the movie.

The number of transactions makes all the difference. Again if one guy bought Sweden say for 10 trillion it would result in the same amount of spending but no activity would be created by it. Not activity that would become income to millions of workers anyway. We're interested right now in activity which generates income for people who currently dont have one (at least I am) knowing that we spent ten trillion is meaningless, we are still at 10% unemployment, so its not going to anyones new salary.

I'm not inserting anything. I'm expanding. The cost of labor is the wage+benefits paid (gross wage, if you will). Insofar as cost < value, people will be hired. This is true for any resource: that's the way in which the apple is the same as the labor.

Your issue hear is basically unemployment. Unemployment is part of a bigger issue, though: underused resources. Capital (with a K) is currently underused as well, but that isn't talked about much because of the lack of human face. But underused resources are the result of the problem right now that you say is because of low aggregate demand.

I don't know what you mean when you say "demands something for you to invest in." The production is what causes a demand for K&L, and a producer needs some reason to think people will want to buy his product. Is that what you mean?

Finally, I think you are making an irrelevant point regarding # of transactions. What if it was one order for $10 trillion worth of bulldozers? It's not the number - it's the type.

I'm glad to see the very interesting back and forth...please do keep it up!

gbgasser/greg: (I have no idea why your handle changes, sorry).

A short while ago, I might have agreed with you concerning your statement about a lack of macro theory prior to the GD. In fact, I now agree with Prof J that this claim is quite false. I recommend that your read David Laidler's book "Fabricating the Keynesian Revolution." He is quite sympathetic with Keynes' GT and acknowledges its contributions, but he dismisses as myth the notion that his work was anything other than a natural progression of existing economic theorizing.

You raise a good point about the difficulty of measuring "uncertainty." On the other hand, its just as difficult to measure "effective demand" (an idea introduced by Hawtrey, not Keynes).

jp: DeLong (in the paper I cite above) claims that abandoning the gold standard contributed to the subsequent rapid expansion. There may be something to this. I may have misunderstood you, but are you suggesting that this event somehow increased uncertainty and held back the recovery? I'd be interested to know what evidence you have for this. Thanks.

"The cost of labor is the wage+benefits paid (gross wage, if you will). Insofar as cost < value, people will be hired"

How do you quantitate "value"? This is starting to sound likeuncertainty or pornography. I'd suggest that there is no difference. The only "value" of an employee is whether you need him to meet the orders you are receiving for your service. If more people come a askin' youll value the next guy who can do what you need done.

"Your issue hear is basically unemployment."

Absolutely! Why isnt it yours? No one can participate in our economy very well without money and no one gets very much money without working. We are ALL better off when everyone is working.

"Unemployment is part of a bigger issue, though: underused resources. Capital (with a K) is currently underused as well, but that isn't talked about much because of the lack of human face. But underused resources are the result of the problem right now that you say is because of low aggregate demand"

The resources were being used just fine when everyone had a job that is now unemployed. The underused resources (of which employable humans ARE a resource) are a direct result of the unemployment.

"I don't know what you mean when you say "demands something for you to invest in." The production is what causes a demand for K&L, and a producer needs some reason to think people will want to buy his product. Is that what you mean?"

Yes thats exactly what I mean. There is no production unless there is credible evidence to believe that which you are thinking about producing is going to be bought. This can be because they are already ordering more than you are currently producing and you are best equipped to ramp up (rather than being competed with by an upstart) or because you have discovered/developed something that is an entirely new way of doing something already being done (the cell phone)

"Finally, I think you are making an irrelevant point regarding # of transactions. What if it was one order for $10 trillion worth of bulldozers? It's not the number - it's the type"

No I dont think its irrelevant if you keep in mind that my goal is in generating new employment. 10 trillion worth of bulldozers would probably employ some new bulldozer builders. 10 trillion of something else might not lead to ANY new employment.

"And I meant my comment about gov't in the pejorative."

I suspected (strongly) that you did. However in your snarkiness I think you stumbled on a truth about our system that is very very hard for many Americans to grapple with.

The value of labor is a matter of entrepreneurial judgment. On balance, the marginal cost of employed labor should approach the marginal benefit, but I don't think we could say they are equal, due to estimation problems.

The issue raised in the blog post, that I thought we were discussing, is business investment. If you want to discuss employment, fine. But being "employed" (i.e. workin' for the man) is not the only way to generate income. So maybe you want to talk about income-generating opportunities?

Keep in mind that unemployment is not just a demand issue, it is also a supply issue. Many who became unemployed were in construction, and thus were in an unsustainable field. To the extent they are getting unemployment benefits, the costly (and painful) adjustment can be delayed, and thus keep measured unemployment rates higher.

You have actually confirmed what I was saying about transaction type not number.

The reason government can force you to buy stuff is because they have a monopoly on coercive power. Government spending doesn't necessarily add value on net since it is a transfer agent, not an agent of creation.

Im sure that Keynes was not the only guy to think about these things, Darwin was not the only to consider evolution either but it IS fair to say, I think, that he was the first to look at unemployment in the light which he did. His paradox of thrift was a new (published and discussed) concept and his focus on unemployment as THE source of macroeconomic dysfunction was unique in his day and counter to what the classical mainstream economists of that time considered worthy of attention. I have no problem acknowledging that Keynes work represented a natural progression, however the implications of it troubled too many economists who were wed to the paradigms of the day.

I'd suggest that the notion of effective demand is meaningless. If someone with money comes through your door you will respond by selling him what you have. THATS effective demand. If their arent enough people with money running around................?

Jeeeeez, "entrepeneurial judgement", "uncertainty", "estimation problems"..... is their anything tangible we can get these industry titans to rely on. Why must we all be held up just because these guys dont have a functional crystal ball?

"The issue raised in the blog post, that I thought we were discussing, is business investment. If you want to discuss employment, fine. But being "employed" (i.e. workin' for the man) is not the only way to generate income. So maybe you want to talk about income-generating opportunities? "

Well yes, but more specifically why investment was scared and uncertain. My point is this... GET CUSTOMERS COMING THROUH THE DOOR and most of the uncertainty will go away.

"Keep in mind that unemployment is not just a demand issue, it is also a supply issue. Many who became unemployed were in construction, and thus were in an unsustainable field. To the extent they are getting unemployment benefits, the costly (and painful) adjustment can be delayed, and thus keep measured unemployment rates higher."

You seem to be arguing the McConnell argument, that unemployment benefits are keeping people unemployed. I guess you think the minimum wage is a problem also... if only we could get people to work for less we'd all be better off. Maybe we can get them to donate their labor.

"You have actually confirmed what I was saying about transaction type not number."

I always agreed with that, just not the nominal level of transactions. You simply quoted a number and I said that was incomplete. Seems we now agree.

"The reason government can force you to buy stuff is because they have a monopoly on coercive power."

Govt doesnt force anyone to BUY anything from them. They actually BUY things from private suppliers, usually at a much higher rate than private parties exchange with each other ($1000 dollar toilet seats anyone). They can enforce taxation. They do have legal tender laws. I dont see that as a problem.

"Government spending doesn't necessarily add value on net since it is a transfer agent, not an agent of creation."

A purely ideological statement, not an economic one. Dont make me list all the things which govt has created which have added enormous wealth in and of them selves and have facilitated the wealth creation of numerous private entities.

This is not some sort of appeal to the virtues of a command economy, simply recognition that oversimplistic ideas of "wealth", "work" and "value" are just that......... oversimplistic.

Entrepreneurial judgment simply means deciding how much a particular job function is worth to the organization. It is uncertain, but the more experienced a company is, the less uncertain they are about the value of a job function.

My reason for bringing up consumer spending a while ago is to point out that consumers are spending as much as they were before. Businesses don't want to invest and it is not because of currently low sales. Sales are fine, cash is high. The story is that businesses don't want to embark on new ventures.

The effects of unemployment insurance and minimum wage on employment levels are well known, so it's not a personal opinion. It's a demonstrated regularity.

Gov't has taxation and legal tender powers, right. Taxing and spending are transfers of resources. And if you don't know why legal tender powers are a problem, then you have much more reading to do. And not of the Keynesian type.

We don't have to talk about government creation & transfer here, since that's a huge topic on its own. But know that my position is not ideological, but is based on years of reading and observation.

You're wrong about sales. Aggregate sales are down from '08 levels. Cash is high because the costs have been cut (lay offs) and they are spending less elsewhere as well. A recent article showed that decreased present sales was listed as a higher negative on businesses outlook than taxation levels.

"The effects of unemployment insurance and minimum wage on employment levels are well known, so it's not a personal opinion. It's a demonstrated regularity."

We are just going to have to agree to disagree over this. I'll just leave you with a microeconomic suggestion.. why dont you volunteer to take a pay cut to help the economy? Keynes demonstrated the fallacy of the "cost of labor" reasoning. Unfortunately too many are ideologically wed to low labor costs as a cure for recessions to acknowledge his arguments. There are numerous studies to refute your position but I wont bother to ask you to read them. I will ask you however, would free labor be the answer??

Do you think we'd be better off if we had multiple currencies? If each state had their own currency or each county? I'm open to this idea but I dont see it as being a simpler less "gameable" system. Seems to me we just need to stop running most of our monetary operations through our private banks and letting them take their cut of all govt spending via our $4$ debt issuance nonsense.

What do you mean by sales? I am making the point that consumption is not the culprit. Down from 2008, sure. But not by very much (see www.bea.gov, real GDP, chained dollars). What's way down is what the BEA calls gross private domestic investment - long-run purchases. Both of these can constitute sales, but that aggregation is a fallacy. What's really down is expenditure on housing, but that's probably a good thing. And, remember what I said earlier: a big area of unemployment is the construction industry.

I'll be happy to read some good studies that show minimum wage and UI don't reduce labor supply. Have you got a couple favorites?

Entertain the idea that Keynes was wrong. And you're argument about me taking a pay cut doesn't make sense, since I don't see how that would contribute to lowering someone else's cost or raising their value. In fact, it's a good thing I get paid, since I had occasion today to engage some labor to do some work for me.

Free labor is clearly bananas, since no one would supply their labor at such a price.

On multiple currencies, government control is not the answer, whether it's federal or state or local. On this issue, a very good reference is Selgin's "Theory of Free Banking." It's now available for free. Vera Smith also has a nice book, but it's a little old now (1936, I think).

My last reading suggestion is Hazlitt's "Failure of the New Economics," which is a point-by-point refutation of Keynes General Theory.

I think DeLong is not properly defining what he means by “leaving the gold standard” in the essay you link to.

The U.S. did come close to leaving the gold standard in late April 1933 when gold exports were prohibited. The dollar floated for some 9 months. But the U.S. re-instituted the gold standard (albeit in an altered form) in late January 1934 when the Treasury promised to redeem dollars in gold again (this time at a devalued $35 per ounce, not @$20.67 per ounce, and only in favour of certain actors).

In those 9 months the US a) reduced the dollar’s gold content b) confiscated citizen’ gold and c) abrogated the gold clause, but in the end it would return to a gold linked dollar, and therefore I don’t think the U.S. ever “cast off” the gold standard as DeLong says.

“Leaving the gold standard” is a very granular concept; it happened in stages, not one step.

While a) may have spurred a short term boom of sorts, both b) and especially c) would have dramatically increased uncertainty. What sort of evidence would convince you? I guess I’m appealing mainly to common sense on this one.

What do I mean by sales? THIS; http://economix.blogs.nytimes.com/2010/09/14/whats-holding-back-small-businesses/?ref=business

It actually addresses the business uncertainty question and breaks it down in an interesting way. Why is it a fallacy to aggregate consumption and private gross domestic investment as part of total sales?

Entertain the idea that Keynes was wrong about WHAT? That unemployment is from a lack of jobs not because workers stopped wanting to work? That the fallacy of composition doesnt hold true?That we ALL can decide to save 25% more of our salaries and NOT cause unemployment? I am not an economist, but I dont think I have to be either to appreciate the substance of the argument which Keynes was introducing at the time he made it. The GD wasnt a simple recession that would have worked itself out without the govt screwing it up. Thats not to say that everything the govt tried was salutary but the private market did not have the tools to reverse the spiral. The gold standard was also hamstringing the economy, essentially fixing the amount of money, and asking interest rates to handle all the adjustments.

"me taking a pay cut doesn't make sense, since I don't see how that would contribute to lowering someone else's cost or raising their value. In fact, it's a good thing I get paid, since I had occasion today to engage some labor to do some work for me."

You are right, I agree completely. Now why does that logic not apply to the minimum wage worker or any other worker? You're not special in the value of your income. Everyones income is a potential source of income for someone else. This 'cut labor costs" strategy ends up becoming a circular firing squad where everyone is pointing to everyone else as overpaid and the only one who actually gets cut is those whom it is POLITICALLY feasible (not necessarily economically sound) to attack. Its bullying plain and simple, in my view. Lets make our companies not rely on the easy "lay off a few workers" strategy to keep their bottom lines healthy. Lets force them to be more creative. Many European firms have done quite well and been quite successful even with their "socialist" labor laws.

Cutting labor is the easy way out and it DOES have human costs associated to it, whether you care about that or not.

I will check out Hazlitts book but I think I can already write it myself.

There's a good discussion regarding this graph here: http://cafehayek.com/2010/09/finally-some-evidence-from-krugman.html

The difference between consumption spending and investment spending is that consumption, by definition, does not lead to growth. Consumption goods are valued for themselves. Investment spending leads to economic growth. Thus, they are quite different.

Keynes was wrong about many things, but my favorite, which you mention, is the paradox of thrift. Final sale of goods is important, sure. But businesses get the necessary funds to expand from peoples' savings. The more people save, the more projects businesses can take on and the more they can grow. A sudden increase in savings (in a country, say) would probably be temporarily contractionary, but it would put the country on a higher growth trajectory.

A business can't pay a worker more than they are worth to the business without taking that money from another part of the business, including raising prices to the customers. If I started goofing on and not doing my job, I would shortly find myself out of one. A minimum wage sets a cost above the value of low-skilled jobs, that's the problem.

Businesses dont get the necessary funds to expand from peoples savings, savings fell the entire 2000s and businesses were expanding. Thats a gold standard paradigm myth. There is no " market of loanable funds" out there.

Let me ask you this, if tomorrow everyone decided they were going to stop eating out and simply eat at home, would any restaurant business survive? If no restaurant could pay there rent or mortgage how many banks would fail? Now, it wouldnt even take everyone , how about 50%?

The truth is in todays system savings is the residue of investment. It doesnt drive investment, investment leads to savings. Without investment there is nothing to save. Classical theory has it backwards. Just like they think that increased bank reserves leads to more lending, no, increased lending leads to banks seeking out more reserves to meet the requirements.

Most people when they "save" are actually purchasing a financial product which is no different than buying an already built house. Buying a stock or a bond on the secondary market is not investment in the way macroeconomists use the term. Certainly you dont think I'm investing when I purchase a house that has already been built? "Investment" is the generation of new capital goods which presumably increases employment and growth opportunities. Almost none of what people do in their 401k or MM savings is investment, its a purchase of an already created good in the hope they can sell it later for a profit.

Btw I found Hazlitts book online and downloaded the entire thing form mises' site. Just getting started. Lots to say about the first 50 pages though, will bring up at another time.

Savings of American households may have been going down, but savings of foreign households were going up, so on balance global savings was up a little bit from 1980-2005. That's from the ECB.

The remainder of your post is nonsense. I'm sorry to tell you that, but you have a long way to go. I recommend starting with some basic economics (David has a really nice book, available on his website). But I simply cannot take the time to breakdown all your misconceptions. Nice chatting with you though.

Greg: If memory serves, the paradox of thrift idea was not original to Keyenes (I'm pretty sure that the Stockholm school talked about it earlier, but I will check). It doesn't really matter too much in the present context, but again, I recommend Laidler's book to you. I think it will lead you to modify your views a little bit.

The exchange between Greg and Prof J is classic. In a nutshell, it is Keynes vs. Hayek (though this is far to simplistic a characterization). It also shows me how far a discussion can go without appealing to a formal economic model. We can go some way, but ultimately fall short. Each side believes the other to be speaking nonsense.

In fact, I think that each side is potentially making sense in the context of a given set of assumptions. The challenge is to make clear what these assumptions are. I can imagine an hypothetical world where an exogenous increase in saving leads (at least temporarily) to recession. I am not, however, very comfortable with the assumptions that deliver this dynamic (at least, the way I am thinking about it now).

In any case, I think that both sides should try to keep an open mind here. Let's see what evidence we can bring to bear in support of different interpretations.

Dont apologize. Its clear from our exchange that you are an Austrian in your views on matters economic. I know exactly where your coming from. Thing is we no longer have a gold standard and the macroeconomic analysis from a fixed exchange rate gold standard world is completely inapplicable in todays floating exchange rate world. In my travels through the economic websites the last 2 plus years (I've visited most) its clear most people A) dont understand this fact B) understand it somewhat but resist the implications of it or C) Understand it, fear it and attack it.

I think one must add that this paradox of thrift doesnt just pertain to savings per se, it applies to paying down debt as well. Using more of your diminishing income to pay down debt becomes problematic for consumption spending.

Ultimately I think a big difference is in the different concepts of money. Keynes did write during gold standard days but I think he saw the limits of such a system (and why he made his barbarous relic comment, which I think got under the skin of the Hayekians more than anything else)Today we have no such standard and our fiat system,floating exchange rate operates at almost 180 degrees to the hard currencies. Money truly is "spent" into existence first and taxed later, thats not theory but operational fact. Taxes do not "fund" govt activities and there never needs to be any savings for lending to occur, loans create their own deposits. This reality really scares some people for some reason.

This stuff has been studied very closely by people who have looked at banking operations for over 30 years. Check out this where Randall Wray tries to "mend fences" with libertarians/Austrians, its not very long.

I understand where you're coming from, although I don't consider myself a straight Hayekian. He saw too much of a role of government for me. I'm more of an anarcho-capitalist.

I disagree with one thing, and am on the fence about another. Friedman said that the test of an economic theory is the degree to which it fits the data. Unfortunately, we've gotten to the point where the data fits a lot of theories. Mises said that a theory must be internally logical and based on obviously true postulates. So, I disagree about taking it to the data for proof, although it is a critical starting point for establishing some basis for discussion.

The thing I'm on the fence about is that Austrians reject the use of formal mathematics in the way that modern economics does. As you probably were, I'm trained in the neoclassical method, i.e. math. I don't use it much, but I see it as a language. The Austrian position is that math takes you in the wrong direction because human action can be modeled so. They use deductive logic. But, math modeling has come a long way, so I'm not convinced of either position.

Greg,

We can continue our discussion anytime, but I think we'll have to establish "accepted definitions" before proceeding. Your blog or mine?

Subscribe To

Favorite Quotations

"Believe those who are seeking the truth. Doubt those who find it." Andre Gide

The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it (P.J. O'Rourke)

But to manipulate men, to propel them toward goals which you – the social reformers – see, but they may not, is to deny their human essence, to treat them as objects without wills of their own, and therefore to degrade them (Isaiah Berlin)

I believe that sex is one of the most natural, wholesome things that money can buy (Steve Martin)

Nothing so needs reforming like other people's habits (Samuel Clemens)